Europe's Real Crisis

March 21, 2012

European policymakers seem to have finally reached an agreement on how to save the continent's troubled economies from a debt crisis. However, the details of the plan suggest that it relies heavily on the ability of these imperiled economies to grow their way out of trouble -- a feat that will be difficult, says Megan McArdle, a senior editor for The Atlantic.

Italy serves as an excellent example of the challenges that these economies will face. Furthermore, because of its economic centrality to the Eurozone, analysts have remarked that the ability of Italy to accept austerity and pay off its debt will likely determine the fate of the whole system. In this regard, Italy will clearly face numerous upfront obstacles to growing out of its debt burden.

Interest payments on its debt, exacerbated by growing fears about insolvency that have driven up interest rates, constitute a full 5 percent of GDP.

These interest payments, which will likely continue to grow with each additional year of deficits, turned what would have been a surplus last year into a deficit equal to 3.6 percent of national income.

Furthermore, for every percentage point that the interest rate on the debt increases, Italians have to divert another 1.2 percent of national income into debt payments.

Exceptional economic growth will be necessary to overcome this debt burden -- growth that seems less likely as austerity measures are adopted that will reduce aggregate demand.

Additionally, exceptional growth in the long run also seems unlikely because of the demographic shift currently taking place in Italy and many other Eurozone countries.

As their populations age, governments owe greater sums to retiree benefits and simultaneously have fewer productive workers to tax.

Though Italy's fertility rate has inched up over time, it is still low at 1.4 children per woman -- well-below the replacement rate of 2.1.

This suggests that this aging trend will likely continue in the near future.